Enterprise Organizational Forms Preview Lecture 1

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Enterprise Organizational Forms PreviewLecture 1

• Sole Proprietorship
• Partnerships vs. Corporations
• Not-for-Profits vs. For-Profits

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Sole Proprietorshipsmall and simple and risky

• You can conduct business as an individual the
  main historical mode.

• You and your enterprise are co-defined
• You pay taxes on the profits.
• You are responsible for debts.
• Not much reason remains to be a SP.

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Partnerships

• Multi-person business arrangements evolved
  slowly, often time or event-delimited,
  mercantile.

• Formal (contractual) partnerships
• emerged in response to problems
• Complexity and reach of the business
• Capital aggregation
• Continuity

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Partnerships effects

• Historically, partnerships
• Easy (and cheap) to form
• Had no double taxation of dividends (U.S.)
  report income on personal taxes
• Present problems in dissolution/ death
• Issues with incomplete contracts
• No limitations of liabilities e.g. Lloyds

With recent U.S. changes, little reason remains
to operate in naked mode.
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Birth of the company
Chartered companies (e.g. British East India
Co.)
Through mid-1800s small scale capitalism with
market transactions, esp. manufactures

• Model of legal structure evolves in Britain
  through 1800s
• Corporations became persons under law
• Limitation of liability introduced.

Early 1900s -- managerial capitalism, wide
ownership and separation of owners/ managers
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Modern US corporations

• Persistent existence
• Can finance through equity dilution
• Stock may be easily acquired/ disposed
• Recognized legal status (person) separate from
  shareholders or directors
• Limited liability
• Unless exempt, entity taxed on profits
• Agency problem introduced

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Examples Local Health-Related Companies

• Methodist Hospital, Houston
• Houston Buyers Club
• Houston Eye Associates
• Houston Substance Abuse Clinic, Inc.
• Cyberonics, Inc.
• Quest Diagnostics, Inc.

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Hybrid formsLLCs

• Limited Liability Companies (LLCs/ LCs)
• Aka Limited Liability Corporations,
  professional companies, PLC or PLLC
• Relatively new to the US state statute controls
  formation and regulation
• Hybrid of partnerships and corporations

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Benefits of LLCs

• Limited Liability Companies (LLCs/ LCs)
• Limit owners financial responsibility
• File articles of organization limited info
• Members may participate fully in the company
• Not subject to tax on the entity but may elect
  pass-through like partnerships
• May encapsulate separate assets.

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Hybrid formsLLPs

• Limited Liability Partnerships start Texas 1991
• Previously, limited partnerships could protect
  limited partners from liability but not the
  general partner(s)
• Designed for professional services firms
  partners cannot escape liability for their own
  torts but do not want liability for others
  malpractice
• State laws govern how the limitation works many
  protect only against malpractice not trade debts.
• Check the box regulations (1997)

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Not-for-ProfitsCharitable vs. Social Welfare
Organizations

• What they are and how they
• differ in purpose
• Tax effects on the organization
• Differing donor tax effects

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What is a Not-for-Profit (NFP)?(per the IRS)

• Tax exempt refers here to the status of the
  organization and not effect on donor.
• Two most common NFP types
• 501(c)(3) charitable, educational, etc.
• gt200K public charities have filed
• gt50K private foundations grant-making
• vs. operating

501(c)(4) social welfare organizations
gt120K file under this other types NFP
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501(c)(3) charitable,

• Corporation, community chest, fund or foundation
  with limited activities recognized under
  501(c)(3) by the IRS
• Exempt purposes include charitable, religious,
  educational, scientific, literary, testing for
  public safety, fostering national or
  international amateur sports competition, and the
  prevention of cruelty to children or animals.

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Charitable purposewide-ranging but not
unlimited

• The term includes relief of the poor, the
  distressed, or the underprivileged advancement
  of religion advancement of education or science
  erection or maintenance of public buildings,
  monuments, or works lessening the burdens of
  government lessening of neighborhood tensions
  elimination of prejudice and discrimination
  defense of human and civil rights secured by law
  and combating community deterioration and
  juvenile delinquency.

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Examples of 501(c)(3)s

• Consumers Union educational
• Ford Foundation private foundation
• United Way public charity
• UT Campus Cat Coalition cat control
• Red River Athletic Conf. amateur sports
• Low Income Taxpayer Clinics defined by statute
  Fed matching funds available
• ExxonMobil Foundation cultural/ educational

What forms are precluded for NFPs?
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A few 501(c)(3) statistics

• As of 2001, 501(c)(3) filers had
• 1.0Trillion in net worth
• 895B in total revenue
• 211B in contributions
• 122B in public contributions
• 89B in government grants
• 630B in program service revenue
• 861B in total expenses
• 739B in program expenses
• 109B in management/ general expenses
• Source IRS

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Source http//www.guidestar.org/news/features/fd
tn_expense_2005.pdf
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What 501(c)(3)s cannot do

• Pay earnings to private shareholders
• Lobby for legislation
• Campaign for or against political candidates
• Dissolve and then distribute assets to
  individuals or non-qualified organizations
  state law controls.

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Hospitals as charitable entities

• Based on British common law relief of poor
  education religion social good.
• In U.S. precedent set during Civil War
• 1923 charitable as relief of poverty
• 1956 financial ability standard
• 1969 community benefit standard

State law controls exemption from state taxes
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Most hospitals in U.S. are 501(c)(3) entities

• 2003 data (http//www.bizstats.com/emprodhealth.ht
  m)
• Taxable 1345 with 40B revenue
• Exempt 5340 with 330B revenue

Health Care NFPs received 93.2 of revenues from
selling program services (2001, IRS).
Question Do FP and NFP hospitals behave
differently?
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501(c)(4) social welfare

• Must be at least community-wide
• Civic associations qualify tenant, homeowner
  and social clubs do not.
• Exempt from paying taxes on earnings donations
  generally not tax deductible
• Effectively bound by the same political rules as
  501(c)(3)s but may lobby for germane
  legislation
• Dues allocated to lobbying not tax exempt
• Other aspects of political process in gray area

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Examples of 501(c)(4)s

• NAACP
• National Rifle Association
• National Organization of Women
• National Association of Cancer Patients
• Note the advocacy nature of these
• Often a 501(c)(4) has a 501(c)(3) education
  foundation.

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NFPs and tax rules

• NFP income is essentially tax exempt.
• They are liable for unrelated business income
• tax (UBIT) trade regularly carried on with
  public, unrelated to purpose other than internal.
• NFPs cannot just sit on large portfolios.
• Within limits, 501(c)(3) donors receive a tax
  deduction (not a tax credit) in effect, society
  subsidizes gifts per the donor tax effect.

Question Why are hospital gift shops staffed by
volunteers?
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501(c)(3) tax treatment contentious

• although business income not related to a
  nonprofits mission is subject to tax, much of it
  escapes taxation. (CBO, Taxing the Untaxed
  Business Sector, July 2005)
• Untaxed business sector generates at least 5.3
  of NDP of that, NFPs producing private (not
  public) goods generate 3.4 of economys NDP.

Question what would happen if the Feds taxed
NFPs on these gains?
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NFPs and Financing

• Qualified 501(c)(3) bonds are tax-exempt
  qualified private activity bonds issued by a
  state or local government, the proceeds of which
  are used by a 501(c)(3) charitable organization
  in furtherance of its exempt purpose.
  http//www.irs.gov/pub/irs-pdf/p4077.pdf
• Here, tax exempt refers to the returns to the
  lender. Effects discussed later in course.

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Key Take-away Messages

• How you organize determines tax, finance
  instruments/ costs, and liability.
• Society supports a wide range of charitable and
  social purposes, but
• While all tax exempt organizations are
  non-profit, not all non-profits are tax-exempt.